Wall Street Waits on Washington

Three questions pending in Washington are poised to roil
markets: When will the Federal Reserve taper quantitative
easing? When will the government shutdown end? and Will
Congress fail to raise the debt limit? How these issues play
out is likely to have lasting effects for a year or more.

Speculation over when the Fed will start tapering has been
looming over markets since Fed chairman Ben Bernanke tipped his
hand in May during his testimony before a joint congressional
committee. Although the Fed surprised investors last month when
it said that economic conditions did not yet support a
reduction in its $85 billion in monthly bond purchases, the
very next week Charles Evans, head of the Federal Reserve Bank
of Chicago, confused matters further when he said that tapering
could be announced as early as the next Fed meeting on October
2930. Uncertainty about tapering could be exacerbated by
turnover in membership of the Feds policymaking arm, the
Federal Market Open Committee, including the departure of
Bernanke, whose term expires in January.

Congress continues to be at a stalemate as it contends with
the political fallout of the government shutdown. The partisans
are digging in deeper than ever. The GOP had demanded the
defunding of the Affordable Care Act, better known as
Obamacare, even though the new health insurance exchanges
officially launched on Tuesday, the first day of the
shutdown.

The deadline to raise the debt limit is October 17. For
every dollar the debt limit is raised, speaker of the House
John Boehner has been demanding that government spending be
reduced by one dollar  what has come to be known as the
Boehner Rule. Congressional Republicans have
shifted focus to the rest of a wish list of concessions,
however, including a one-year delay of Obamacare and approval
for the Keystone XL oil pipeline. As in 2011, the GOP is using
the prospect of a government default as leverage.

President Obama says he will not negotiate on the debt
limit. But keep in mind, however, that he had said as much in
2011, then struck a last-minute deal. He had a strong incentive
to compromise two years ago: his reelection. The White House
feared a refusal to deal would hurt the presidents
prospects for a second term. Of course, that motivation is
gone, although congressional Democrats face midterm elections
in November 2014.

For their part, House and Senate Democrats have countered
the GOPs ultimatums by demanding the reversal of domestic
spending cuts enacted as part of sequestration. Neither
partys desired outcome is in the realm of possibilities.
Because of incongruence in their political goals, elements of
each party see the shutdown as serving their political
interests.

Any break in the budget impasse will be a stopgap measure
funding the government for a month or two. We will have a brief
respite around Thanksgiving, with the infighting to resume
before the year-end holiday break. Congress will pass another
continuing resolution, setting up another budget fight early
next year. This routine could continue right up to Election
Day, November 4, 2014.

In the good old days  that is, December 2012 
Vice President Joe Biden and Senate minority leader Mitch
McConnell could sit down, craft a compromise, push it through
the House of Representatives and kick the can down the road.
That is not going to happen this time.

McConnell is up for reelection as one of the ten most
vulnerable incumbents in Congress. He faces the Tea
Partyaligned challenger in the Kentucky Republican
primary, businessman Matt Bevin, who has hammered McConnell for
rounding up GOP votes to pass the Troubled Asset Relief Program
bank bailout in 2008. Bevin has also aligned with Texas Senator
Ted Cruz in his war on Obama­care, claiming that McConnell
has equivocated in his opposition to the health care law.

If McConnell survives the primary, he is likely to emerge
wounded. His Democratic challenger is Kentucky Secretary of
State Alison Lundergan Grimes, who, according to a poll
conducted in early September by the Public Campaign Action
Fund, leads McConnell 46 percent to 40 percent (with 14 percent
undecided). Grimess prospects for defeating McConnell,
however, are complicated by the recent announcement by liberal
Democrat Ed Marksberry that he will run for the seat as an
independent.

Whatever happens now, the GOP will make certain the debt
limit comes up again before the November 2014 elections.
Its an excellent device for the Republican Party to raise
the profile of the issue, justifying cuts in federal spending
and mobilizing its base. Democrats will respond by demanding
restoration of domestic spending cuts and protection of Social
Security and Medicare.

Continuing uncertainty about QE3, the federal budget and the
debt limit will be the new normal until voters put one party or
the other in firm control of the government. Thanks to
gerrymandering, bigger campaign spending under Citizens
United and the Senate filibuster, that is not going to
happen anytime soon.